I’m still way under invested and like being that way with the market inching higher on hopes and dreams of a fiscal cliff resolution that will solve all of our monetary problems.  The way the market has been behaving, the resolution will also solve the drought facing the mid-west and the south.  As happy as I am to play it safer right now with so much up in the air, I don’t like missing out on the upside movement we’ve seen recently.  I found a way to remedy that and mixed up my usual trade with a hedge.  It’s really just a put spread, but with a different plan for how I’m going to work it.

While VNQ was trading at $64.22, I sold two VNQ January $66 puts for $2.575 each and bought two VNQ January $64 puts for $1.325 each.  I received $246.95 after paying $3.05 in commission for the $1.25 spread.  I started with an order for two at $1.30, but after a few hours of it not executing I lowered it by a nickel and it hit within a minute.  Actually, I started with an idea of selling naked puts.  The $64 strike puts looked like I could get $1.30 per contract.  I thought I could sell two, get a 2.36% buffer from a loss and potentially gain $15.1%.  Before getting to far on placing that trade, I thought I should look at the spreads.

I saw that by lowering my probability (having to gain 2.77% vs. a 2.36% buffer), I could get the same return, but cut my downside risk by a huge amount.  I can only lose $153.05 the way I did this trade.  If I sold naked puts, my downside risk would be over $200 if recent support held.  If it didn’t, I could lose another $2-300 if VNQ hits its June lows.  Below that, it could turn into thousands on panic selling.  I don’t expect panic selling, but I don’t have that risk with this trade.

Ideally, we’ll see some selling before there is any resolution to the fiscal cliff.  If we get that, it should hit hard around the end of the year and/or the beginning of January.  If I see any type of reversal to the upside after this assumed upcoming dip, I’ll take a profit on the long puts and stay short the $66 strike puts for the run back higher.  If it looks like the move lower is going to last, I’ll just take my $153.05 loss and move on.

On the other hand, I could be wrong and I might end up making a quick gain on this trade as it is.  VNQ’s 10 day moving average (dma) is about to have a bullish crossover above its 20 dma and 50 dma.  It already broke above its trend line of lower highs.  The next trend line of lower highs (from an earlier starting point) is above $65.50, closer to the 100 dma.  That might be where I’m forced to exit early from this trade.  I’ll have to see what’s going on at the time.  Returning to the September high above $69 is always a possibility.

Risk/Reward Breakdown:

  • Potential profit: $246.95
  • Money at risk: $153.05
  • Potential put spread return: 161.35%, 98.5% per month
  • Downside cushion: no cushion, need a gain of 0.86% to break even
  • Short put delta: 0.7899
  • Timing remaining before expiration: 7.1 weeks
  • Position close goal/limit: I’m aiming for full profit, but don’t expect it.  Willing to take the 200 share assignment and the profit on the long puts.

I’m looking at a similar trade on MDY too.  I’d like to see more of a retracement to the 10 dma before I pull the trigger on that one.  It also depends on how quickly that happens.